Will the 25% tax-free pension lump sum be abolished by the time I retire? Steve Webb replies

I'm 47, and I have an interest-only mortgage held jointly with my wife that is due for repayment shortly after my 62nd birthday.

I have a few pensions, including a personal pension that I've been paying into for over 20 years.

I'm considering increasing my payments into this pension and using the 25 per cent tax-free lump sum from it to go towards paying off my mortgage. It seems like the most tax-efficient way of saving.

Peering into future: Will Government axe 25% pension tax-free lump sum before you can take advantage of it?

However, I realise that there are a couple of risks: the rules may change and remove the 25 per cent tax-free lump sum option; and the minimum age for withdrawing from a pension may continue to rise and be above 62 when I need the money.

There may be others. What are your views on this approach and these risks?

Share this article

HOW THIS IS MONEY CAN HELP

Steve Webb replies: I generally try to avoid using my crystal ball when answering readers’ questions, but your question highlights the fact that the wisdom of decisions we take today may be affected by policy changes in the future over which we have no control.

Given how frequently things like pension tax relief limits have been changed in recent years, I can well understand why you wonder if other elements of the system on which your plan depends may be likely to change.

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

Naturally, I can only give you my best guess, but I think that there is a good chance that both the 25 per cent lump sum and the ability to access pensions well before state pension age will both continue for some years to come.

Starting with the tax-free lump sum, there is pretty much annual speculation that a cash-strapped government will try to raise money by scrapping or capping the tax-free lump sum.

Indeed, the very fact that it is technically known as the ‘pension commencement lump sum’ rather than ‘tax-free’ lump sum has made some people wonder if its tax-free status is at risk.

However, it would be a big political risk for any government to scrap the tax-free status of lump sums which have already been built up.

Back in the 1980s the reforming Chancellor Nigel Lawson took a good look at this but announced that he would not be touching the ‘much-loved, but anomalous’ tax-free lump sum.

I am sure that Chancellors since then have also had a look but have come to the same conclusion.

If tax-free lump sums were abolished overnight, the government could raise several billion pounds a year. But this would be a huge upheaval for millions of savers and would create a storm. Not least because many people – such as yourself – have made financial plans based on the assumption of a continuation of the current policy.

As an alternative, a government could cut or cap the tax-free lump sum for the future only – perhaps keeping it only for contributions made before a certain date. But this would save the Treasury very little cash and would still create a big fuss.

Chancellors want measures that raise lots of money with little fuss, and this sort of change would do the opposite. So, although you can ‘never say never’, I think tax-free cash is probably safe for the foreseeable future.

Turning to your second question, the ability to access your pension pot at 55 is obviously relatively new and therefore might be more vulnerable to change.

The basic idea is that people are able to access their cash 10 years before state pension age. As state pension age rises, the current 55 will rise, but only to 57 in the late 2020s when the state pension age rises to 67.

Interestingly, the government is not currently planning to raise the age of access to 56 when the state pension age reaches 66 in October 2020. This was specifically to give people time to adjust.

There is, of course, nothing that says access should always be possible 10 years before state pension age, and it could be cut (for example) to five years.

But for someone of your age, with a state pension age of 67, even a cut to five years would still allow you to access your pension at age 62 which is in line with your plans.

I should stress that governments can – and do - change their mind about things and make changes with relatively little notice. You therefore need to think about a ‘Plan B’ – what you would do if a future government did change the rules.

But my best guess is that a strategy of using a tax-free lump to pay off an interest-only mortgage has a good chance of surviving likely changes in legislation.

ASK STEVE WEBB A PENSION QUESTION

Former Pensions Minister Steve Webb is This Is Money's Agony Uncle.

He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.

Since leaving the Department of Work and Pensions after the May 2015 election, Steve has joined pension firm Royal London as director of policy.

Steve will do his best to reply to your message in a forthcoming column, but he won't be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.

Please include a daytime contact number with your message - this will be kept confidential and not used for marketing purposes.

Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here.It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.

Do you want to automatically post your MailOnline comments to your Facebook Timeline?

Your comment will be posted to MailOnline as usual

We will automatically post your comment and a link to the news story to your Facebook timeline at the same time it is posted on MailOnline. To do this we will link your MailOnline account with your Facebook account. We’ll ask you to confirm this for your first post to Facebook.

You can choose on each post whether you would like it to be posted to Facebook. Your details from Facebook will be used to provide you with tailored content, marketing and ads in line with our Privacy Policy.